The federal government’s push to close tax loopholes this year has changed the rules for investors looking to protect wealth and maximize gains.
And there are more changes coming. The financial services industry is grappling with how to handle America’s new tax-information sharing rules, known as FATCA, while the Canadian government wants to continue eliminating what it says are unintended advantages in the tax system.
1) New dividend tax credit rates
The purpose of the tax credit is to compensate people who get dividends from a company for being taxed twice—once through the corporate income tax, and again through their personal tax.
In Budget 2013, the government said taxpayers receiving non-eligible dividends were being overcompensated, and lowered the gross-up (pre-tax company income) factor of non-eligible dividends to 18% from 25%.
It also changed the gross-up factor of the dividend tax credit to 11% for non-eligible dividends. The amount of tax saved by earning dividends instead of salary depends on each provincial tax rate. The change affects dividends paid out starting Jan. 1, 2014.
“It’s a significant change,” says Maureen McCullough, KPMG’s senior manager, taxation.
“It changes the decision as to whether or not to pay a bonus, to extract profits from the corporation, or to leave the profits in the corporation and then distribute them by way of a dividend at some point, in a year or in the future. That’s a decision people make every year,” she explains.
2) More reporting requirements for foreign property
The CRA updated its requirements for reporting ownership of foreign property.
In the T1135 form, taxpayers must now report the name of the institution holding funds outside Canada; the property’s country (before, only the region was required); and the dollar amount of income generated by the foreign property (if any).
3) Graduated tax rates for testamentary trusts
The budget proposed a comment paper on whether testamentary trusts should be taxed at graduated rates, rather than at a marginal tax rate. Inter vivos trusts created before June 18, 1971 are taxed at a graduated rate, as are testamentary trusts. But newer inter vivos trusts are taxed at the highest personal tax rate—29%. When receiving income from a trust, beneficiaries are taxed at their own personal tax bracket.
The different treatments let beneficiaries access two different tax rates: their own and the trust’s.
“This tax treatment raises questions of both tax fairness and neutrality in comparison to the treatment of beneficiaries of ordinary inter vivos trusts and taxpayers receiving equivalent income directly,” says the CRA in a comment paper released this June.
The government wants to eliminate the tax benefits of the graduated rates. It proposed the change and the public had until Dec. 2 to weigh in. Now it’s up to the government to implement new rules.
Moving testamentary and newer inter vivos trusts to potentially the highest marginal tax rate may prompt trustees to change payments to beneficiaries, says McCullough.
“It basically is really causing the income to be allocated out to the beneficiaries,” she explains.
4) Nixing 10/8 transactions
Under this strategy, investors would borrow from their insurance companies at an interest rate of 10% to make an investment with an 8% return. Since the loan was investment-related, after-tax borrowing costs would fall to 5.5%, netting the policyholder 2.5% return. In the 2013 budget, the federal government said tax benefits would no longer apply to these transactions going forward.
“That’s fairly sophisticated tax planning,” says McCullough, who adds that for that reason it won’t affect many people.
Policyholders already in these plans have until Jan. 2014 to withdraw without penalty, though some will have to keep them and pay the 2% difference if they’re not otherwise insurable.
5) First-time donor super credit
For clients who donated money for the first time since 2007, the government handed them significant tax savings this year. Under the new credit, they can get an additional 25% tax credit on top of existing federal and provincial breaks.
“This means you can get a 40% federal credit for up to $200 in donations and a 54% credit for the part of donations that is over $200 but not more than $1,000,” states the CRA on its website.
Consider mentioning this to clients who haven’t yet shared the joy this holiday season. Also mention program is slated to end in 2017.
6) Leveraged insured annuities
This was an investment used by business owners that combines an annuity, a life insurance policy and a loan within a private corporation. Instead of using company capital to buy the insurance, the loan is used. The interest on the loan is written off as a business expense, reducing taxes.
The federal government said that tax benefit was unintended, and eliminated the shelter.
7) Ramping up for FATCA
This U.S.-led tax information sharing initiative is causing governments to re-think their rules on tax evasion. But the actual law has yet to come into effect in America. It’s scheduled for July 2014, but this may be delayed as implementation details are still up in the air.
FATCA will oblige non-U.S. financial institutions to send the IRS information on clients who are eligible to pay American taxes. Americans living in Canada and some Canadian snowbirds are considered U.S. persons for tax purposes.
Canada is currently working on its response, which could delay the implementation further. The agreement is also meant to be reciprocal—meaning Canada could get America’s information on Canadian tax-avoiders.
It’s also unclear whether dealers or fund companies will share compliance duties under FATCA. Under Canada’s current laws, the responsibility is shared, but FATCA states one entity must be in charge—without saying which it should be.